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2001 BW 50

SPRING 2002

INVESTING FOR GROWTH

Mid-Cap Stars
Video games, car auctions, biotech, and housing are some stalwarts in this group


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Too big to be undiscovered gems but too small to command the respect of large-cap stocks, mid-caps as a category are often overlooked. That's too bad, because there are some great investment opportunities in this pack. Granted, last year wasn't exactly a smash: The Standard & Poor's MidCap 400 index fell 5.2% during the year ended Feb. 15. But that performance bested the S&P 500-stock index, which lost 16.8% in the same period. Moreover, since its launch in 1990, the MidCap 400 has been a solid winner--up 280% vs. the S&P 500's 243%.

To help investors, BusinessWeek and USA Today teamed up to examine the performance of the MidCap 400. We measured and ranked the one- and three-year total returns for the stocks in the index, then added the two rankings to come up with the best performers (table, page 144). The list covers the far-flung corners of industry, from biotechnology and video-game software to the gritty but apparently lucrative business of running junked-car auctions.

Some themes emerge from the list. Resilient consumers and low interest rates, for example, were a boon to homebuilders and financial firms. Builders such as D.R. Horton (DHI ) and Lennar (LEN ) benefited as Americans, perhaps fed up with stocks, turned instead to something they understand: investing in real estate. Brisk house sales and refinancings, prompted by low interest rates, meant good business for mortgage lenders such as New York Community Bancorp (NYCB ), TCF Financial (TCB ), and Independence Community Bank (ICBC ).

Based in Arlington, Tex., D.R. Horton--which builds both starter homes and those for families looking to upgrade--has scorched the charts, with a total return of 67.6% for the 12 months ended Feb. 15. Americans' seemingly insatiable demand for housing, even amid recession, pushed revenue up 21.9%, to $4.5 billion, and net income 34.1%, to $257 million, in the last fiscal year. While Horton already builds in 20 states, it plans to expand with its purchase this year of Schuler Homes, a top West Coast builder.

Choosing winning mid-cap stocks in 2001 was more a matter of finding top companies than identifying breakthrough industries. Take Gilead Sciences (GILD ) in Foster City, Calif. Although biotech stocks were flat in 2001, Gilead's stock returned 97.3%, in part because the company began selling Viread, an HIV treatment. Unlike many other biotech businesses still struggling to develop salable products, Gilead has five on the market. Thus the company's revenues grew 19.5%, to $233.8 million, last year.

In a slow economy, drug stocks do well because people must buy medicine. They don't have to spend on amusements--but they will, given the right products. That's why Activision (ATVI ), which saw its shares returned 74.6% in the year ended Feb. 15, is so hot. The software company makes video games for consoles such as Sony's PlayStation 2 and Microsoft's Xbox. This is one industry that has cruised through the recession: Video game hardware, software, and gear sales jumped 42.4%, to a record $9.4 billion last year, says NPD Group.

But Activision, based in Santa Monica, Calif., has outperformed even its peers by keying video games to extreme sports such as skateboarding and snowboarding. Tony Hawk's Pro Skater, for example, is a game that features the Michael Jordan of skateboarding. Strong sales of Tony Hawk's Pro Skater 3 for the PlayStation 2 helped Activision report 26% higher revenue--$621.5 million--during the first nine months of the fiscal year ended in March, 2002, and a 111.2% increase in net income, to $41.4 million. This year, Activision will also release games tied to upcoming movies such as Spider-Man, X-Men 2, and Blade II, says CEO Robert Kotick.

Many investors may still shudder when they hear the words Internet and stock in the same breath. But Copart (CPRT ) in Benicia, Calif., which auctions cars that insurance companies have junked, credits the Net for its growth spurt. Roughly 25% of its $253.9 million in revenue during fiscal 2001 came from buyers--often body shops and junk-heap operators--who bid online instead of traveling to auctions. Think of Copart as the eBay of battered cars.

Having more bidders usually means higher prices--and thus more commission dollars--for Copart, says Jayson Adair, the company's president. That's one reason Copart's net income rose 45%, to $42.7 million, during fiscal 2001.

While Copart is part New Economy and part Old, some classic industrial companies led the mid-cap universe. One was tractor manufacturer AGCO (AG ), which spent much of the past year trying to lower overhead. Even in a slow economy, the company boosted net income by 545.7% last year, to $22.6 million. During the same period, revenue rose only 8.8%, to $2.5 billion.

Another industrial notable is Airgas (ARG ) in Radnor, Pa. It's trying to boost growth by acquiring the U.S. packaged-gas business of rival Air Products & Chemicals. The buy gives Airgas a further 100 facilities in 30 states, plus access to assets that generated $223 million in sales during the last fiscal year. More acquisitions could be in the cards, says CEO Peter McCausland, since half the market is controlled by independents.

Tech companies may still be suspect, but several mid-cap techs managed to excel: CDW Computer Centers (CDWC ), Symantec (SYMC ), and GTECH (GTK ). Stealing market share from weaker players has been the strategy of CDW Computer Centers in Vernon Hills, Ill., which sells to small and midsize companies, mostly over the telephone. While CDW's 3.1% revenue growth, to $4 billion last year, may not sound impressive, it is when you consider that the company managed any sales gain while prices on computers and servers dropped 18%, says CEO John Edwardson. CDW's net income grew 4.0%, to $168.7 million.

Others, such as Symantec in Cupertino, Calif., were in areas of tech not as hurt by Corporate America's spending cuts in that sector. In 1999, Symantec focused on the quirky niche of antivirus and security software and stopped trying to be a smaller version of Microsoft. The timing couldn't have been better. Scares over Nimda and Code Red viruses panicked consumers and corporations alike. That helped Symantec increase corporate sales: About 70% of its $760.7 million in revenue during the nine months ended Dec. 31 came from businesses.

At GTECH, in West Greenwich, R.I., the secret to surviving the tech drought has been its base of government clients not affected by the slowdown. The company makes the systems that connect state-operated lottery terminals. Just two years ago, investors would have frowned on GTECH's slow revenue growth, usually 2% to 4% a year. Revenues rose 6.4%, to $735.1 million, during the nine months ended Nov. 25. But GTECH has impressed investors with earnings that are predictable, because it has long-term contracts with many states. Last year, it shipped many of its software-development jobs to lower-priced facilities in Poland and India, which helped power the firm's net income during the nine months to $57.4 million, a 232.6% gain.

If the mid-cap stars had anything in common, it was being prepared for the economic slowdown by having costs in line or the right products to sell. One of the most dramatic examples of that was Boston's Eaton Vance (EV ), which returned 29.9% during a 12-month period when most other mutual-fund companies were hard hit by redemptions and crumbling asset values. Eaton Vance was ready because it sells mutual funds that work in both good times and bad. Especially popular last year: the Eaton Vance Government Obligations Fund, which invests in short-term government bonds. While hardly as exciting as some of the growth funds that dazzled in 1999, it was exactly what investors were looking for, to escape the sinking stock market. "We swam upstream when others were struggling," says CEO James Hawkes. You could almost say that about the entire mid-cap sector.


APRIL 2, 2002



By Matt Krantz, USA Today



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